Towards the end of September 2015 oil appeared to have found a range within which to trade. The key support at $42 made up the lower bound, while technical and psychological resistance at $50 formed the upper.

Given the long term downtrend, we believed that oil would be more likely to break lower than higher if the range was broken, and therefore looked to initiate a short position. Using USO as our chosen vehicle the equivalent lower and upper bounds were $14 and $17 respectively.

We sold a USO Nov15 -$16/+$18 Vertical Call Spread for a net credit of $0.37. This means we sold $16 calls on USO, but also bought $18 calls simultaneously to avoid unlimited risk. Both sets of calls had November expirations and the difference in their prices meant that we received $0.37 at the beginning of the trade. The $2 spread between the strikes of the calls and the net credit received meant that the maximum gain would be $0.37, with downside limited to $1.63.

If our view that oil was likely to remain low was correct the spread would move from $0.37 to $0.00, with both calls becoming worthless and expiring out of the money. On the other hand if we were wrong, we could have lost $1.63 as the spread could move to $2 with both options in the money. The simple payoff diagram below illustrates this.

It is clear that our potential risks were much greater than the rewards, but we viewed the probability of oil remaining low as particularly high. This meant that the risk reward dynamics of the trade were positive as the expected losses were much lower than the expected gains.

USO initially moved higher in the two weeks after we opened our short, leading our position to show a minor loss for a while, so in hindsight we were early signalling to open this trade. However, the risk reward dynamics were still positive upon opening the positon, and remained so whilst we held the trade as we were confident that oil would remain close to its lows.

This resulted particularly favourably for us, as USO fell after moving close to the top of its range. Then to add to this, the minor rebound following this in fact increased the gains on this trade. The bounce was reversed, allowing us to exit this trade near the lows for USO and gain an increased amount of time premium, which further increased profits. We therefore banked close to the maximum gain on this trade buying the spread back for $0.04, earning a 20.25% profit. This gain is more than triple those of an outright USO short over the same time period. Therefore, overall we believe the trade and use of the short vertical call spread strategy worked well.